It’s not just happening to U.S. Treasuries. Bond prices are plunging and yields soaring for developed economy bonds across the globe. The benchmark 10-year yields on government debt in the United States, Germany, the United Kingdom and Japan are all up by 20 to 25% in the last month.
That would be huge volatility even for investors in stocks. For bond buyers it’s scary enough to send them screaming out the door—which, of course, just increases the volatility.
On December 8, yields on 10-year U.S. Treasuries hit a six-month high of 3.33%. That’s a full percentage point higher than the October low. And it’s a shocking 0.76 percentage points above the yield just a month ago on November 8. (Treasury prices rallied on December 9 but they’re down again today.)
In that same one-month period yields on German 10-year bonds are up 0.62 percentage points, yields on 10-year U.K. bonds are up 0.53 percentage points, and yields on Japanese 10-year bonds are up 0.29 percentage points.
The reasons for the move up in yields—and down on prices–on U.S. and German government bonds are pretty clear. For U.S. bonds the proposal from the Obama White House and Congressional Republicans to add $1 trillion in debt over the next two years to the U.S. balance sheet by extending the Bush tax cuts has just put a capstone to the feeling that the U.S. government doesn’t have an inkling of a plan for dealing with the U.S. deficit. For German bonds the worry is that Germany is going to get stuck bailing out its neighbors no matter how much protesting it does now.
How much further bond prices and yields go in the current direction will depend on when the bond market thinks it sees some progress on either of these fronts.
Could be a while.
USDA et al, I forgot to add this. Schiller’ method (and logic) of calculating his cyclically-adjusted PE (CAPE) is provided in his book “Irrational Exuberance”. The book is worth owning, but libraries likely stock several copies.
His web site: http://www.econ.yale.edu/~shiller/data.htm provides monthly updates of the supporting data and resulting graphs. Well worth perusing.
USDA, be careful about a one-year PE calculation. It’s the assumed forward (years) earnings that is relevant to calculation of intrinsic value and the basis for purchase decisions.
Best wishes!
livetoride,
I agree that to be sustainable, we’ll need domestic consumer consumption to take-the-ball going forward. For now, investors can ride the trend of corporate spending and foriegn demand. Of late, increasing evidence shows that domestic consumer spending is getting stronger. (As far as market P/E… I’m not sure how Schiller does their adjustment, but most numbers I hear for S&P earnings start at $90. That gives a 13.5 – 14 PE. Pretty good for an environment with such low interest rates. That said, if you’re investing in individual stocks, it doesn’t matter too much, anyway.)
In any case, we’ll have evidence to confirm the consumer spending trend during next earnings season, with some preliminary numbers before then. I expect that once again, most companies will issue “surprise” earnings numbers. As far as investing in the trend goes: to make money, you need to invest before there is absolute certainty in the outcome. If there’s no longer any risk, there’s no more money to be made (or lost).
For more information on the recovery of GDP and corporate profits, see this report from the Department of Commerce showing that both are at new highs:
http://www.bea.gov/newsreleases/national/gdp/2010/pdf/gdp3q10_2nd.pdf
Finally, I agree that this has been a good exchange. It’s good to have to consider alternative scenarios and state our assumptions, so we can all collectively better understand the reasons driving our investment decisions and hopefully become better investors. Thanks for that.
Thanks, USDA, good exchange. Here’s where I fall off the wagon. Collectively (again), corporate profit growth can only be sustained by increasing consumption (after the effects of expense reductions), and if jobs are lacking, where is profit growth? Further, credit continues to contract, so even those with jobs are re-building their balance sheets. Finally, Schiller’s cyclically-adjusted PE (CAPE) rest today at 21.87, not a level at which one should expect much further market upside. Hence, my caution. I read today’s market ebullience as primarily performance anxiety from underperforming fund managers, and “black box” trading of that anxiety. This phenomenon may be “investable” in the short term, but one should not assume a new bull market is being launched.
livetoride,
We’re on the same page regarding jobs. We’ve had another jobless recovery, and I don’t expect unemployment to return to “normal” levels for a long time, for exactly the reasons you gave.
To further clarify my previous posts, my use of the phrase “boost to the economy” is a reference to corporate profits and GDP, not jobs or unemployment.
I used the phrase “natural progression” to refer to the natural release of pent up demand after a period of holding back (during the recession). As you note, businesses have remained reluctant to spend, and that has resulted in the process occurring at a slower rate than usual, though not a stopping of the process itself (which would put a company out of business). The point of my post was that full business expensing would add additional incentive for CAPEX spending on top of that natural process, helping to keep the trend in place.
USDAportfolio is correct. The problem isn’t with the tax cut per se. Tax cuts are generally a net positive for the economy. The problem is when tax cuts aren’t paid for with spending cuts. Because of the tax cut we’ve just given ourselves, we now have an additional $1 Trillion in deficits to look forward to.
This tax cut, as usual, is going to be paid for with borrowed money. Certain politicians are fond of talking in an abstract way about spending cuts and shrinking the size of government, but none of them, Republican, Democrat, or Tea Party, actually walk the walk. This tax deal is more of the same.
Thanks, USDA, for your effort to explain, and adding specifics. I agree that individual companies will benefit from CAPEX expansion, and may even increase staff. But collectively, capacity utilization is at recession-level, so CAPEX for business expansion is clearly wrong-headed. Further, the deep recession has forced many smaller companies to learn how to survive with less staff (more labor-saving technology) and restoring previous staff-levels will likely not occur. Finally, I suspect we see this business cycle differently. You use the word “normal”; I see it as anything but normal, and therefore lacking in predictive quality.
That said, I appreciate you sharing your perspective. Merry Christmas!
livetoride,
I’m suggesting that this year’s trend of increased CAPEX spending will continue through 2012. This is an “investable trend”, so if you already own companies which benefit, their sales should continue to rise, and you should consider holding those companies for as long as the trend seems “solid”. To me, the trend seems safe through at least mid-2011. The natural progression of the economic cycle is already increasing CAPEX spending, and full business expensing would provide an additional incentive keeping the “green light on” for that trend. Companies such as CAT, DE, CMI, PCAR, JOYG, and INTC should benefit. Jim has discussed the trend a number of times.
The wild card will be to determine how much the full business expensing in 2011 is pulling forward future sales from 2012 and 2013. As far as my preliminary considerations can tell at this point, if the tax deal passes, I’d think the green light would stay on through mid-2011 and it would be rational to consider taking some profits between late-spring and mid-summer of 2011. Future events could shorten or extend that date.
Finally, increased CAPEX spending should not result in layoffs or reduced employee benefits. Just the opposite — companies whose sales increase due to the CAPEX spending will be more likely to retain staff and to hire new employees. For example, see DE’s plan to invest $100 million in its Waterloo Foundry:
http://www.deere.com/en_US/newsroom/2010/releases/corporate/9jun2010_corporaterelease.html
Deere is benefiting from increased sales, due to higher commodity prices and increased revenues for farmers. DE, like most large companies, had cut back on CAPEX spending during the recession and built up a cash reserve. DE’s cash (and cash equivalent) balance was 70% higher this year than it was in 2008. (See DE’s income statement and balance sheet for the numerical evidence of what I describe.) With sales increasing and conditions improving, DE feels safe to expand its facilities. DE will have to hire contractors and suppliers to aid in this expansion. In essence, the cash will move from sitting on DE’s balance sheet (doing nothing) to the contractors / suppliers. To supply DE, those companies may need to hire or expand their own operations, as well as buy from their own suppliers. (For instance, they may need to clear land to expand the facility, perhaps driving increased sales to CAT.) This unleashes a virtuous cycle of spending that cascades down that particular supply chain.
USDA, surely you don’t suggest increased CAPEX would be for increased capacity. And, if the CAPEX increase is primarily for cost-reducing technology (internet-based enterprise software and supporting hardware), those lost salaries and benefits will reduced top-line revenue for businesses collectively. So where’s the “boost to the economy”?
Good point, south. Or at least make something temporary only for a good reason. Note: setting a political trap is not a good reason.
On another note, I suspect that if the Obama Tax Deal becomes law, the Investment Tax Credit and Full Business Expensing will lead to further increases in corporate CAPEX spending over 2010 levels. This will provide a positive boost to the economy by moving additional cash from fat corporate balance sheets through the capital goods manufacturers’ supply chains.
Just curious, what occurs in 2035?
Of course USDA is correct. But retire’s post demonstrates the fallacy of “temporary” anything when it comes to the government’s budget- people come to rely on it, expect it, and ultimately demand it such that when it expires, or shortly before it expires, push to have it “extended.” See, e.g, “temporary” unemployment insurance benefits, the “temporary” tax cuts, etc.
If the new incoming congress wants to prove its mettle it should pass a law banning “temporary” anything.
Of course you could wait, untiil you feel that the bonds have gone down as far as they are going.
Then buy into PCN or PGP, or one of the other Hi yield bond funds that PIMCO offers. That is for the dividend hounds out there. Buy cheap and hold, cheap consistant income for retirees, Like me.
A possible option to capitalize on the downward trend in bond prices is ProShares Ultrashort 20+ Year Treasury ETF (TBT). TBT seeks a return of -200% of the return of Barclays Capital 20+ Year U.S. Treasury Index for a single day.
RetireB42035,
I agree terminology can trip people up. Jim is correct in his terminology, though.
Spending money does not cause debt. “Deficit spending” causes debt (unless you have reserves). The debt will go up whether the tax cuts expire or are extended, unless we run a surplus greater than our interest payments on the debt.
“For U.S. bonds the proposal from the Obama White House and Congressional Republicans to add $1 trillion in debt over the next two years to the U.S. balance sheet by extending the Bush tax cuts has just put a capstone to the feeling that the U.S. government doesn’t have an inkling of a plan for dealing with the U.S. deficit ”
Whether you are for increased taxes or not, extending what our current tax rates are does not cause or add to the debt. Spending money adds to the debt. The American people are being brainwashed once again by politicial terminology.